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Kass: The Bear Case for Apple

Sep 24, 2012 | 12:00 PM EDT

Surprise No. 10: Despite the advance in the U.S. stock market, high-beta stocks underperform. Though counterintuitive within the framework of a new bull-market leg, the market's lowfliers (low multiple, slower growth) become market highfliers, as their P/E ratios expand. With the exception of Apple, the highfliers -- Priceline(PCLN), Baidu(BIDU), Google(GOOG - Get Report), Amazon(AMZN - Get Report) and the like -- disappoint. Apple's share price rises above $550, however, based on continued above-consensus volume growth in the iPhone and iPad. Profit forecasts for 2012 rise to $45 a share (up 60%). In the second quarter, Apple pays a $20-a-share special cash dividend, introduces a regular $1.25-a-share quarterly dividend and splits its shares 10-1. Apple becomes the AT&T(T - Get Report) of a previous investing generation, a stock now owned by this generation's widows and orphans.

While I recognize that valuation and concept shorts are usually a free pass to the poor house, Joe Nocera's editorial to me was a reminder that, as Grandma Koufax used to tell me, "trees don't grow to the sky."

There is no better time to consider the negative case for Apple given its marked outperformance and its recent penetration of the $700-a-share mark.

Principal Short-Term Positive: A Blockbuster Quarter

The upcoming quarter will be big for Apple. The fastest ever rollout for iPhone 5 will be accompanied by higher-than-expected margins, as there are two separate cost-reduced models now. Soon everyone will know that, and if not fully in analyst numbers, it will be in buy-side expectations. (See the recent rise in the stock even after what was viewed as a somewhat me-too product launch.)

10 Concerns

Quality vs. price: Apple is now selling less or equal for more money. The company used to sell a better product for more money, which is a great strategy. Its products were simply market-defining, and competitors were not close. Recently, however, things have changed, and competitors have caught up. Now Apple is selling an equal to worse product than the competition for more money (both phones and tablets). That strategy cannot work forever. This is the biggest issue.

Delivering a more complicated product: Products are also getting more complex and Microsoft-like. Apple's challenge is to deliver ever more complicated products (with a lot of new components) in sufficient quantities. See most recent Foxconn issue. Previously, we would never have seen such a story because there were never issues and nobody would dare voice them, especially not an avowed Apple zealot like the author of this interesting article.

The Oracle of Cupertino: Steve Jobs is no longer around to convince consumers that his products are magical. There is no longer a single visionary voice, especially with the vision of Steve Jobs. There are stories floating around about internal disagreements and power struggles given the unique void created by the loss of a single dominant figure in an unusual corporate structure that he controlled.

Increasing product homogeneity: Apple no longer has a huge ecosystem advantage. Most if not all the apps that consumers care about are available on Android and Microsoft (MSFT), which can also run Office apps such as Excel that Apple doesn't. The first-mover advantage might be lessened or lost if Apple continues to try to do everything on a proprietary basis -- for instance, maps (and who wants a smartphone with bad maps?).

Economic headwinds: Some of the markets served by Apple are saturated, and in a worldwide economy facing strong headwinds, consumers may balk at a product that can be purchased at much lower prices from competitors. Until last quarter, Apple never missed consensus expectations during a product transition. There is more to last quarter's miss than transition.

Poor economic proposition for Apple's partners: Apple's carrier partners do not like the economics they give to Apple. Apple's partners have shown that they can and will shift to the good alternatives that consumers seem to like (e.g., Samsung Galaxy).

Roadblocks to new initiatives: Potential business partners in general do not like or trust Apple relative to other initiatives. The music industry and AT&T have not had great experiences with Apple, and the company might find it hard to sign deals for new initiatives.

Product cannibalization: The iPad mini may cannibalize the higher-margin iPad -- or just be a neutral at best.

Growing size mandates delivery of more product blockbusters: An investor better believe in a huge new blockbuster product next year. TV is complex due to relationships with cable companies, set-top box manufacturers and channel guide programmers. Google may one up Apple in the space, as it owns Motorola's set-top box division and has Google Voice already. If it comes to integrating more complex solution for TVs with content, cable companies and other media partners have learned not to trust Apple given the poor outcomes other Apple partners have had (e.g., music industry, AT&T, etc.).

Valuation: Apple's stock is cheap on a P/E basis but arguably very expensive on price/sales (4.4x) and total absolute market capitalization basis ($625 billion).